Tax Tip of the Week | Real Estate - Tax Basis

In an earlier Tax Tip, different tax categories of real estate were briefly discussed, since real estate is a big business, with many people selling and buying properties, you can even find fishers real estate if you're living near the coast. This week we will discuss how a tax gain or loss is treated upon sale by the various classifications as listed below:

1.    Principal residence – Your gain (loss) is calculated by subtracting your tax basis from your sales price. Your tax basis starts with your original cost, adds in any qualifying improvements, and includes most of the selling expenses you incur when sold. Provided certain tests are met, gain is excludable up to $500,000 on a joint return, or $250,000 for a single filer. Exception: Any depreciation taken after May 6, 1997 is usually taxable. Depreciation may have been taken on an office in the home or any business usage. Any loss upon the sale of a personal residence in non-deductible.

2.    Second home – Your tax basis is calculated in the same manner as a personal residence. Any gain is taxed as capital gain. No exclusion is allowed as with a personal residence. No one may designate more than one property as a personal residence. Just as with a personal residence, any loss upon the sale of a second home is non-deductible.

3.    Rental property – The tax basis is calculated in the same manner as a personal residence with one major exception.   Because rental properties are depreciated over time, basis has to be reduced by the depreciation allowed or allowable. Any gain on the sale of a rental property is taxed as capital gain. However, the gain attributable to the depreciation taken could be taxed as high as 25%. This in known as Section 1250 recapture. Any excess gain is taxed as normal capital gain with a maximum rate of 20%. A loss on the sale of a rental property is normally deductible as an ordinary loss (not subject to the $3,000 per year net capital loss limitation).

4.    Investment property – Depreciation is not normally allowed on investment property. A loss is deductible to the extent of capital gains plus $3,000 per year for joint or single filers, and $1,500 per year for a married filing separate return.

5.    Business property – Same as rental property above if owned individually.

6.    Gifted property – Your tax basis in a property received as a gift is the same as the basis was in the hands of the giver.

7.    Inherited property – Your tax basis in an inherited property is generally the fair market value of the property as of the date of death of the decedent, commonly called a “stepped-up basis”.

As noted above, gains and losses are often treated very differently depending upon the type of property. Please understand what your type of property is and that its character may change for a variety of reasons including your intentions. Being able to substantiate all of this may be important.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This week's author – Norman S. Hicks, CPA

--until next week.